China state-run firms: Stifling nation’s vitality

Privatizing behemoths could revitalize economy, correct imbalances

By

WangLan

BEIJING (Caixin Online) — In recent years, the enormous profits of state-owned enterprises (SOEs), once widely considered a good thing, have come under public scrutiny. The core of the problem is monopoly. SOE bigwigs are rapidly expanding their monopolies, relying on growing scale and rising prices to extract huge profits. But these companies bring little technical or organizational innovation to the table.

The vitality of the Chinese economy is being stifled by SOEs, especially central-level, or top, SOEs, and this is borne out by research. In October 2011, the State-Owned Assets Supervision and Administration Commission of the State Council (SASAC) released a breakdown of state-owned assets and earnings information for 102 for-profit SOEs. This showed that in 2010, the capital of 102 central-level SOEs was equivalent to 61.4% of GDP, and their earnings equaled 42.2% of GDP.

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This information is representative of only those central-level SOEs that can be published. There are actually 120 for-profit SOEs authorized by SASAC. 15% of them are legally prohibited from releasing this kind of information. If you include industries outside of those legal requirements, like the tobacco and finance industries, the scope of SOEs is even more alarming. The second national economic census taken in 2008 reported profits of nearly 900 billion yuan ($142 billion) by finance industry central-level SOEs. Banks accounted for 64% of that profit.

These gargantuan SOEs have not only failed to lead us toward a new stage of development, but they have actually inhibited the vitality of the Chinese economy by distorting resource allocation.

China is a rising industrial nation. So logically the manufacturing industry should be our primary focus, but the banks, part of the service industry, have taken the lion’s share. The scale of the banking industry has surpassed that of the United States, a post-industrial nation with a total economy much larger than China’s.

Moreover, a staggering amount of banking capital allocation has been siphoned off by SOEs, especially the central-level SOEs. What’s more, SOEs as great sponges of capital produce very few jobs. Yet employment is a matter of vital importance for a rapidly urbanizing nation. In fact, SOEs are exacerbating the problem. By crowding out private players, they make the employment situation even more unfair.

Next, the scale and reach of SOEs is holding back innovative industries. We require a great number of innovative businesses to make technological progress and economic restructuring possible. But most of the active innovators are small and medium-sized businesses, generally leaders in their own fields.

But the ubiquity of SOEs on the Chinese business landscape complicates the situation. Strong SOEs hog up too many resources and exert enormous pressure on smaller downstream companies. This in turn distorts the normal supply-chain relationship, which makes survival of the fittest impossible. Potentially fit small- and medium-sized businesses are forced to work with SOEs. In some situations, those businesses risk operating in a gray zone and sometimes even acting illegally.

Next, SOEs have exaggerated the risk of fluctuation within the Chinese economy.

Economic activities tend to be cyclical, and China is no exception. Macroeconomic policies (monetary or fiscal) are needed to tighten up or boost the economy.

State-owned vs. private firms

Chinese businesses can be divided into two categories. First, businesses represented by central-level SOEs, and, second, the large number of private businesses. Every time the government expands, the first is highly elastic, which means they receive more capital. The second is much less elastic, since they receive some, but much less, capital during expansion.

When the macro policy contracts, the first is inelastic, which is to say it will contract but to a very limited extent. On the other hand, the second category is highly elastic during contractions, and will contract much more.

It is impossible for the government to reach its desired results of expansion or contraction, since the first category occupies too large a proportion of resources. This is one reason that China has never enjoyed real success in macroeconomic adjusting. In fact, the government’s preference for SOEs has heightened the risk of economic fluctuations.

Then there is the belief that heavyweight SOEs are vital to the nation’s security and political stability. If we toss aside ideology and only look at history, we find that this belief is simply unfounded.

Throughout ancient Chinese history, there always existed a belief that the enrichment of the central treasury was the foundation of a strong nation and stable society. But the frequency of dynastic change disproves this. At the end of the Qing Dynasty, the nationalization of privately funded railroads incited the Railway Protection Movement in 1911, which in turn led to the fall of the dynasty. This shows that enriching the people is more beneficial to social stability. In recent history, the economy before reform and opening-up of the late 1970s, when the proportion of state-owned business was nearly 100%, was teetering on the verge of collapse. What kind of stability is that?

Privatization

So why does China need SOEs? There might be two reasons: some industries which must be monopolistic and industries important to national security. But we should make a list of industries that fall into those categories, and update it as technology advances. It is important that only SOEs be permitted into industries on the list and private industries should be forbidden. I estimate that there are not more than 15 such industries in China today. If you say three companies per such industry, then only about 50 SOEs would be required. The rest should all be excluded.

In principle, SOEs should exist only at the national level. Some SOEs can continue operating at the provincial level. But below the provincial level, there is absolutely no need for them. Grassroots governments should return to their original function of providing services to the public.

The aim of reforming SOEs is to restore vitality to the economy. China has gone through 30 years of rapid economic growth. According to the experience of developed nations, a period of medium growth will follow. But given the size of China’s population, and since rural and urban populations are so disparate and resource allocations so distorted, the goals of economic development are far from being accomplished. Consequently, the search for a new growth impetus has become the crux of future development. SOE reform could be a turning point for us.

What would happen if we privatized some SOEs?

If we privatize one-third of central-level SOE and two-thirds of local state-owned enterprise, assets mounting to about 1.3 trillion yuan would be involved. Most of these companies are listed. If they are valued at ten times the price-earnings ratio, the total valuation would add to about 13 trillion yuan on private markets. Assuming privatization did not affect the nation’s control over certain key industries, this could revitalize the economy and correct the economic imbalances caused by SOEs. Privatization could mitigate fiscal pressure and remedy the debt problems facing local governments. It could lead to greater investments in public services and might even bring about long-term economic growth. Read this commentary on Caixin Online.

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